China Faces Hard Choice Between Deleveraging and Economic Growth

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A leading expert on China’s financial system says that the country’s banks are still under heavy stress, and that Beijing will soon need to make a hard choice between effective deleveraging of the economy and propping up GDP growth.

Christopher Balding, an associate professor of  business and economics at the HSBC Business School of Peking University Graduate School, points out that Chinese banks remain in a beleaguered condition according to official data.

In an opinion piece written for Bloomberg Balding highlights a rise in the official loan-to-deposit ratio  from 65.8% in June 2015 to 71.2% at the end of March, as well as lagging growth in new deposits relative to loans after a peak was tapped in 2015.

While new loans were equal to 100.1% of new deposits in 2017, across the first five months of 2018 they’ve risen to 104%.

In order to bolster the health of banks PBOC has increased its provision of funds to them by more than 300% since 2015,  rising to $1.5 trillion in total.

PBOC has also driven a shift towards credit of longer maturity, implemented a cut in the reserve ratio in April to help Chinese banks pay back medium-term lending facilities (MLF), and expanded the range of collateral accepted for MLF to include lower-grade debt.

These moves are contrary to the much-vaunted deleveraging campaign pursued by Beijing over the past two years, which seeks to reduce the mountain of debt accumulated since the Great Financial Crisis.

According to Balding China is pursuing conflicting goals by simultaneously pushing for deleveraging while striving to maintain economic growth, and that instead of reducing leverage regulators are actually shunting it into other channels. such as interbank certificates of deposits.

While a big part of the deleveraging campaign involves bringing shadow banking activities back onto balance sheets, this has heightened the need amongst Chinese banks for credit due to capacity constraints.

PBOC is using injections of funds and maturity extensions to deal with the issue, but Balding say these measures are “only delaying things,” as well as “eroding banks’ ability to respond to potential shocks,” particularly given the huge amount of new capital still needed by banks.

“If it is ever going to break this cycle, China must use the time it buys by lengthening repayments to institute some actual credit restraint,” writes Balding.

“Ultimately, China must confront a stark question…it can’t deleverage and boost the economy at the same time.”

 

 

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